To fix or float, what is the answer?

Has New Zealand’s interest rate market fundamentally changed and does that mean attitudes towards floating versus fixed rates should change as well?

Monday, July 2nd 2001, 10:23AM

by Jenny Ruth

Stuart
Marshall, economist at merchant bank Bancorp, thinks it has and
attitudes should change.

He argues that he demise of the Reserve
Bank’s monetary conditions index (MCI) in March 1999 and
its replacement with the more steady and stable official cash
rate (OCR) has meant a structural shift in the way New Zealand
interest rates are priced.

"In this new OCR environment, and despite
travelling through a period when monetary policy has completed
a full tightening-neutral-easing cycle, the yield curve has managed
only a fleeting foray with a negative slope (when long-term rates
are higher than short rates)," Marshall says.

In other words, during the whole cycle,
longer-term interest rates have usually been higher than short-terms
rates.

Under the MCI regime, rates were generally
higher and more volatile and for long periods long-term rates
were lower than short term-rates.

That means under the OCR regime, fixing
the interest rate on a loan will generally be more expensive.

"If we are correct that the interest
rate market structure has indeed been altered, then policy should
be reviewed," Marshall says.

"Absolute certainty of interest cost
is likely now to come at a consistently higher price. Is that
certainty still worth it?" he asks.

While his questions are directed at corporate
treasurers, the logic should generally be the same for home loan
borrowers, Marshall says.

The exception is when we get market distortions,
as is happening right now.

Lenders’ profit margins on floating
rate loans are currently nearly double that on fixed-rate loans.
Most floating rates are now about 7.7% compared with the 90-day
bank bill rate of 5.83%, a difference of 1.93 percentage points.

But one-year fixed mortgages are being offered
at between 6.7% and 7.1% (and at least one offer at 6.45%), compared
with the one-year swap rate of 6% in the wholesale market, a margin
between 0.7 and 1.1 percentage points.

And three-year fixed mortgages are mostly
being offered at 7.8% compared with the three-year swap rate at
6.8%.

"At the moment, if this is the low
for short-term interest rates, then it means the variable rate
is likely to be going up. That means locking away for three years
at 7.8% is a good thing," Marshall says.